On Friday last, Bombay Stock Exchange Sensex closed at a 33-month high of 20445, while the broader Nifty closed at 6143. Optimistic stock market experts predict that the indices will rise further. Sensex going past the 21000-mark seems well within the realm of possibility. It will be useful to try and understand the reasons behind the recent surge in indices if only to see whether the factors that are driving up the stocks are likely to endure.

Second, should these high stock prices be seen as a vindication of the economic progress in the country?

Third, do these record-breaking Sensex and Nifty mean anything substantial to the ordinary investor? As has been the case several times before, it is the foreign institutional investors (FIIs) who are driving up the stock prices. In just two days of last week FII investment was of the order of Rs. 5,000 crore. Over September, Sensex rose by a phenomenal 2,500 points on the back of Rs.25,412 crore capital inflows. As the market rally is not confined to just the index stocks, it is safe to assume that the broad-based rally may last longer than previous occasions. But does that mean that India's positive factors — as perceived by the dominant overseas investors — continue to attract investment?

India generally positive

There are, to be sure, a number of positive factors. The Indian economy has been resilient. The industrial performance has been good, while the performance of the services sector, the other traditional growth driver, is back on an even keel. But it is expected that the turnaround in agriculture is causing nearly all the excitement among economic forecasters. Not only will that have an impact on inflation expectations, but it will also boost rural incomes substantially.

The corporate performance has also been good with a number of stocks getting re-rated at higher levels. Specific sectors such as automobiles and banking recently have had a spectacular run and the share prices of individual stocks in these sectors have touched the unprecedented levels.

There is every reason to think that investors' perception on the economy and a large number of stocks will be positive for some more time to come but that does not guarantee a degree of permanence or stability to the indices.

That is because FIIs have been known to flee the country at a short notice and for reasons that are only remotely connected to India.

The global economic crisis and the aftermath showed how the risk perceptions of overseas investors can change and not always rationally as one would expect or hope from a category of investors who possess abundant skills and knowledge and even more relevantly have huge resources at their command.

It is worth noting that at the height of the global financial crisis, which had its epicentre in the U.S., major investors flocked to the U.S. money and government securities market. This they did by selling their investments in markets such as India, which ironically were far less affected by the crisis.

When the crisis started lifting major investors rediscovered India and other emerging markets as their risk aversion started abating.

The important point is that India and China may be the hot favourites for the FIIs at the moment but no one can guarantee that their stay here will be for long. India's high ranking is on a relative basis and it is naive to think that it will remain so.

Finally, what has this huge market rally done to small investors?

Reports suggest that domestic mutual funds and other institutions were less active than the FIIs.

Hence, it is likely that while the net asset values of mutual funds have gone up, they are not commensurate with the rise in indices.

Which also mean that these investors who were advised by the government to route their investments through mutual funds have not benefited as substantially as one has thought.

There is a danger that market hype will draw first time investors to access the market at these levels.

There is evidence to suggest that small investors have been marginalised in the primary and secondary markets. At these dizzy levels of stock prices, the retail investor is probably better off as a spectator.

Keywords: Indian economy

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